The mega cap technology companies have roared back to life in 2023, with the NASDAQ 100 rising 40% in the first half of the year. The “magnificent 7” (Apple, Microsoft, Tesla, Meta, Alphabet, Nvidia and Amazon) have performed even better, rising a staggering 61%. They now account for a whopping 27% of the S&P 500 index (which is weighted by market capitalisation, or put simply, market value), while the other 493 stocks in the index contribute 73%. Compared to their 61% return over the first 6 months, the remaining 493 of the S&P 500 were up about 6% (bringing the index return to June 30 of 16.9%).
Put another way: investors that have bought equal-weight indices or individual stocks have likely dramatically underperformed the big tech stocks and the S&P 500 index overall.
This tech surge has been fuelled by the launch of ChatGPT and other developments in Artificial Intelligence, which have enamoured investors. There’s no doubt AI has some exciting applications, both for our lives as humans as well as investors. But have the big tech stocks run too far?
Big Tech Are Great Businesses–Is that Enough?
The big tech stocks are incredible businesses that dominate their markets. They operate digital commerce ecosystems that are winner-take-most or winner-take-all marketplaces, they have incredible brands that consumers love, a history of strong revenue growth, fortress balance sheets and strong secular tailwinds that see demand growing far into the future. But according to a 2019 study by Morningstar and the CFA Institute led by Roger Ibbotson, popular securities often underperform unpopular stocks–for the simple reason that strong brands are known to the public, which can often mean their shares are overvalued.
Microsoft and Apple: Trees Don’t Grow to the Sky
Apple (NASDAQ: AAPL) rose 50% in the first 6 months of 2023, and Microsoft (NASDAQ: MSFT) rose 43%. They now constitute 14.5% of the entire S&P 500 index and generated 5.4% of the index’s 16.9% total return YTD (that is, nearly one-third of the index’s total return came from just two stocks!).
Combined, these two tech trillionaires combine for a whopping $5.5 trillion market value. According to David Poppe at Giverny Capital Asset Management, this equates to 14 million U.S. single family homes (roughly all of the homes in Florida and Texas) or the gross domestic product (GDP) of Japan, the third-largest economy in the world with 123 million people!
Amazon–Pandemic Boom or Bust?
Amazon (NASDAQ: AMZN) shares rose 55% in the first half of the year to once again join the trillionaires club. Undoubtedly Amazon has an incredible position in both retail and cloud computing, but one interesting note is the company’s capital expenditures (that is, spending on property, plant and equipment such as new warehouses). This was an incredible US$150 billion over just the past 3 years. This is more than triple the pre-pandemic average, and doesn’t even include company leases. Cloud computing is seeing phenomenal growth, particularly as financial services providers now shift their operations off-premise, but it remains to be seen whether Amazon can achieve a great return on investment on this extraordinary level of spending.
Tesla–Industry Champion with a Cult Following
Tesla (NASDAQ: TSLA) is up 112% for the first 6 months of 2023 and once again sports a market cap of over $830 billion. This is roughly equal to the entire rest of the auto industry combined. That includes the likes of Honda, Toyota, Ferrari, Stellantis, Ford, General Motors, Volkswagen, Nissan, Hyundai and BMW. Yet it contributes less than 1% of total industry sales.
To be sure, Tesla is growing at an extremely high rate–global deliveries surged 83% in 2Q 2023, fuelled by the sharp price cuts put in place earlier in the year. But unless Tesla truly dominates the automotive industry with unprecedented profit margins, it seems likely that investors are betting on more than car sales to drive the future share price. In fact, leading brokerage firm Interactive Brokers (IBKR) says that Tesla is the most traded stock on their platform, showing Musk’s undeniable popularity.
Nvidia–GPUs, AI and More
Semiconductor giant Nvidia (NASDAQ: NVDA) has been the biggest beneficiary of the AI phenomenon. The graphical processing unit (GPU) manufacturer recently unveiled a new batch of products and services tied to AI, including a new robotics system, gaming capabilities, advertising services and networking technology. It also announced that the July quarter sales quarter would be US$11 billion, which was a staggering 50 percent ahead of analyst estimates.
Importantly, it remains a small business (by big tech standards) with revenue of “only” around $27 billion in 2022, which should continue to grow at a high rate given the secular tailwinds.
Nvidia’s valuation, on the other hand, remains highly optimistic. Even with the incredible growth forecast in 2023, Nvidia trades at an eye-watering 26.5 times the consensus revenue estimate of US$43.5 billion (that’s right, revenue, not net profit or EPS).
This brings to mind a famous quote “What were you thinking?” by the CEO of Sun Microsystems, Scott McNealy, talking about how his company’s valuation reached 10 times revenue at the height of the dotcom bubble:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realise how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
Advertising Giants Rebound
The digital advertising market struggled late in 2020 and early in 2023, and as their market share has increased, advertising behemoths Alphabet (NASDAQ: GOOG) and Meta (NASDAQ: META) move more in tandem with the overall industry. Their recent results spurred a rally in both companies’ shares, which had been under pressure late into 2022.
Meta in particular had received a lot of unflattering attention due to CEO Mark Zuckerberg’s Metaverse initiatives, which had severely dented company profits. But some recent commentary about curbing his audacious spending, a return to revenue growth and the recent launch of Threads (a microblogging app to compete with X–formerly Twitter–that went live earlier in the month, adding more than 100 million signups in just the first week) have caused a big rally in Meta’s share price. A very low valuation multiple didn’t hurt either.
Alphabet has always been one of the more stable share prices, showing far less exuberance than others in the big tech universe. It has nearly regained pandemic-era popularity though, with a return to revenue growth and more importantly, long-awaited profitability in the Cloud division and more measured losses in the experimental “Other Bets” division.
Dotcom 2.0, Pandemic 2.0, or Stronger for Longer?
The rally in large technology stocks has been fast and furious in 2023 so far, reminiscent of the boom earlier in the pandemic. It’s hard to bet against the tech titans given their great products, incredible balance sheets, and constant innovation that delivers new and exciting opportunities.
It is worth keeping the Morningstar/CFA Institute study in mind though. These are high-profile companies that are incredibly popular with both consumers and investors, and any challenges to their dominance could bring on unwelcome surprises. It will likely pay to be selective, and given their neglect, the other 493 stocks in the S&P 500 may be an enticing hunting ground for future outsized returns.
Disclaimer: Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG) are currently held in the TAMIM Portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.